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The Repatriation tax and the 962 Election for Americans with a U.K. corporation

The U.S. 2017 tax reform has made it very problematic for an American residing in the UK to conduct business through a UK corporation. Operating through a UK corporation exposes the expat to two new taxes: Repatriation and GILTI. This article will discuss the little known 962 election, how it can be used to reduce Repatriation tax liability, and some issues that must be considered before doing so.

A numerical example is helpful. An American living in the UK has been operating a CPA sole practice or family restaurant for 30 years through a wholly owned UK company. After paying UK corporate income tax on profits over the years, the company has $500,000 in retained earnings in its bank account, which the expat is counting on for retirement. Under the Repatriation tax, the expat is now personally liable for $87,700 (17.54% * $500,000) of that amount.

How is this tax paid? In eight annual payments, with the first payment of 8% (or $7,016) being due June 15, 2019 (as a result of the extension achieved from the U.S. Treasury).

Let’s assume that the expat has no personal foreign tax credits to use to offset to the Repatriation tax. In other words, in previous years the expat has already used all personal income tax paid in the UK to offset U.S. income tax.

Section 962 of the U.S. Internal Revenue Code (“IRC”) may help. Section 962 allows the expat to be treated as a corporation for a specific year (say in 2017) solely for purposes of the Repatriation tax (and other Subpart F income which taxpayers rarely have).

Why does this help? Simple. If we assume an average UK corporate tax rate of 20% over the past 10 years, then approximately $100,000 ($500,000*1.20%) of UK corporate tax has been paid. As the UK corporation never owned U.S. taxes, it never utilized these taxes as credits on any U.S. corporate tax return.

And if the expat utilizes the 962 election in 2017, there are two potential benefits: (1) ability to use the corporate taxes paid in the UK to offset the Repatriation tax, and (2) enjoy the lower corporate Repatriation tax rate.

In the real world, situations are rarely black and white – i.e. lots of corporate credits but no personal credits. For example, if the expat has some personal tax credits available, the point at which the 962 election becomes beneficial requires analyzing different numerical scenarios, taking into account many factors, such as gross-up rules under section 78. However, in cases where the UK corporation has a significant pool of unused tax credits and the expat has none, the 962 election may make sense.

The remainder of the article will discuss one significant landmine that may arise when using the election. And it is important to state until now, 962 has rarely been used, so there may be others:

Post-2017 distributions. What happens when the UK corporation finally distributes the $500,000 to the expat? If no 962 election was made, no additional U.S. tax is paid by the expat (IRC 959). UK tax, however, may be due. And if 962 election was made? Bad news: all the distributions out of the accumulated earnings, beyond what was paid on the Repatriation tax, are subject to U.S. tax (IRC 962(d))! Ouch. At what rates? Most likely personal marginal rates. Double ouch.

An example will help illustrate this. In the above example, if no 962 election is used and no personal tax credits are available, the expat would be liable for $87,700 in Repatriation tax, but no more U.S. tax would be due upon distributing the $500,000. But under 962, let’s assume that the $100,000 in corporate tax credits eliminated any Repatriation tax liability. Upon distribution of the $500,000, the expat would pay U.S. taxes at the marginal rate, or as much as $185,000 ($500,000 * 37% – the highest marginal rate). Triple ouch!

Does 962 make sense? It may in the following three situations, but careful analysis is required: (1) When the UK corporate tax credits far outweigh the personal income tax credits available, and/or (2) when the expat has no plans to withdraw the money in the corporation, and/or (3) the UK taxes due at the time of distribution may render any U.S. additional taxes minimal.

In summary, in planning around the Repatriation tax, the 962 election is an option. However, careful analysis is required to achieve the best results under U.S. and UK tax law. A totally different analysis exists for the 962 election with regard to GILTI in 2018 onward.